This content is for educational purposes only and does not constitute financial advice. Always do your own research before providing liquidity and understand the risks involved.

Liquidity provision has evolved from simple traditional models to sophisticated concentrated approaches, changing how liquidity providers can deploy their capital. As the Radix ecosystem continues to evolve with various DEX implementations offering both models, understanding the differences between traditional and concentrated liquidity is key to help you make more informed decisions.

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The Evolution from Traditional to Concentrated Liquidity

Traditional Liquidity: “Uniswap V2”

Traditional automated market makers use a simple but elegant model where liquidity providers deposit equal values of two tokens (like 50% hWBTC and 50% hUSDC). These tokens create a pool available at all prices from $0 to infinity, using the constant product formula (x × y = k) to determine prices.

Traditional LP Example: You deposit $1,000 ($500 worth of hWBTC at $100,000 = 0.005 BTC + $500 hUSDC). Your liquidity spreads across the entire price curve from $0.00001 to $1,000,000+ per BTC. You earn a small percentage of all trades that happen in the pool.

The Inefficiency Problem

Traditional AMMs have a fundamental inefficiency. An asset might trade within a ±20% range for weeks, yet your liquidity spreads from nearly zero to infinity. Perhaps 75-85% of your capital never touches a trade. You earn fees only on the small portion actually used.

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What is Concentrated Liquidity?

Concentrated liquidity allows providers to allocate capital to specific price ranges rather than the entire curve.

The efficiency gains from concentration are real but vary widely:

• Theoretical maximum: Up to the 1000x range for extremely tight ranges
• Practical reality: Usually 2-20x for volatile pairs, 20-100x for stable pairs
• After competition: Your share of fees decreases as more liquidity crowds popular ranges, reducing individual returns

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Even a 3-5x improvement can significantly boost returns but keep in mind that efficiency only applies while the market price remains inside your chosen range. Once it leaves, your position earns zero fees until adjusted.

Direct Comparison: Traditional vs Concentrated

Illustrative Example - Traditional Liquidity Position:

• Deposit: $10,000 ($5,000 hWBTC at $100k = 0.05 BTC + $5,000 hUSDC)
• Price range: $0 to infinity
• Active liquidity at current price: ~$200 worth
• Example daily fee earnings: $2 (0.02% daily)*
• Management required: None

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Illustrative Example - Concentrated Liquidity Position:

• Deposit: $10,000 (allocated to $90k-$110k range)
• Price range: $90,000 to $110,000 only
• Active liquidity at current price: Full $10,000
• Example daily fee earnings (while active): $100 (1% daily)*
• Management required: Active monitoring and rebalancing

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In this example, the concentrated position earns significantly more fees - but only while the price stays in range.

*These are illustrative examples. Actual efficiency gains vary dramatically based on:

• Token pair volatility
• Trading volume distribution
• Competition from other LPs in the same range
• Rebalancing costs relative to position size
• Protocol-specific implementations and fee tiers

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How Each Model Works

Traditional Liquidity Mechanics

When you provide traditional liquidity, you add equal values of each token and receive LP tokens representing your pool share. The pool automatically rebalances as prices change, you earn fees from all trades continuously, and can withdraw anytime by burning your LP tokens.

Price Movement Example (Illustrative): Start with 0.05 hWBTC + $5,000 hUSDC at $100,000/BTC. If BTC rises to $150,000 (50% increase), the pool automatically rebalances to approximately 0.0408 hWBTC + $6,124 hUSDC. You're still earning fees at all prices, with a total value of $12,247 (impermanent loss of ~$253).

Concentrated Liquidity Mechanics

With concentrated liquidity, you first choose your range boundaries, then deposit tokens in a ratio that depends on the current price within that range. Your liquidity is only active when the price stays within boundaries. You receive an NFT (Liquidity Receipt) representing your specific position and must manually rebalance when price exits your range.

Price Movement Example (Illustrative): Create a position for the $90,000-$110,000 range at $100,000. If BTC rises to $120,000, your position becomes 100% hUSDC (converted all hWBTC to hUSDC at $110,000) and stops earning fees. You've effectively been forced to sell all hWBTC at $110,000, missing the move to $120,000. Position value: ~$10,232 versus $11,000 if you had just held (impermanent loss of $768).

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Key Benefits and Drawbacks

Traditional Liquidity

Advantages:

• Always earning fees regardless of price
• No active management required
• Simple to understand and execute
• Predictable impermanent loss curve
• No rebalancing costs
• Works in all market conditions

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Drawbacks:

• The majority of your capital sits idle
• Lower fee earnings per dollar added to the pool
• Cannot express market views
• No flexibility in positioning

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Concentrated Liquidity

Advantages:

• Higher capital efficiency (typically 2-20x for volatile pairs, up to 100x+ for stable pairs while the price remains inside the chosen range)
• Increased fee potential when ranges are optimized
• Express directional market views
• Create multiple position strategies

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Drawbacks:

• Requires active daily management
• Can earn zero fees when out of range
• Severe impermanent loss at boundaries
• Potential ongoing rebalancing costs (trading fees)
• Steep learning curve
• Time-intensive monitoring

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Risk Comparison: Traditional vs Concentrated

Impermanent Loss Differences

Traditional liquidity experiences gradual, predictable impermanent loss that spreads across entire price movements. At a 2× price change (a doubling of one asset’s price), you face roughly 5.7% IL. At 5×, it’s about 25.5%.

Concentrated liquidity, on the other hand, experiences sharp impermanent loss effects at range boundaries. As price moves through the range, the position gradually converts from one asset to the other. Once price exits the range, it becomes fully one-sided and stops earning fees.

For example, if you set a range from $100,000–$150,000 with the initial price at $125,000, and BTC rises to $160,000:

• A traditional position still holds both assets with about 0.8% IL
• In comparison, a concentrated position has already converted entirely to hUSDC by $150,000 (selling hWBTC gradually from $125,000 to $150,000), missing any gains beyond the upper boundary.

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Advanced Risks in Concentrated Liquidity

Liquidity Competition and Range Crowding: Popular price ranges become overcrowded, diluting individual returns. If many LPs target the same "obvious" range (like round numbers or technical levels), your share of fees diminishes significantly. 

Out of Range  Risk: Unlike traditional LPs who always earn something, concentrated positions become inactive when the price exits your chosen range. You then stop earning fees.

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Scenario Comparison (Hypothetical Example)

Consider a week where you add $1,000 in a hWBTC/hUSDC pool. BTC starts at $100,000, ranges between $90,000-$110,000 with high volume Tuesday through Thursday, spikes to $130,000 Friday, then settles at $120,000 over the weekend.

Assumptions: 0.3% swap fees, $50k daily volume through your liquidity during active days

Traditional LP Performance (Example):

• Fees earned: $15 (consistent all week, small share of total pool)
• Impermanent loss: -$5 (≈0.45% for 20% price increase)
• Net result: $1,010 (+1.0%)

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Concentrated LP ($90k-$110k range) (Example):

• Fees earned Tue-Thu: $45 (10x capital efficiency while in range, 3 days)
• Fees earned Fri-Sun: $0 (position inactive above $110k)
• Position value when price exits at $110k: $1,025 (gradually sold hWBTC from $100k-$110k, average ~$105k)
• Rebalancing cost: -$5 (swapping ~$500 to reenter new range at 0.3% + gas)
• Final position value at $120k: $1,025 (missed gains from $110k to $120k)
• Net result: $1,025 + $45 - $5 = $1,065 (+6.5%)

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Wide Concentrated LP ($80k-$140k range) (Example):

• Fees earned: $25 all week (3x efficiency, always in range but lower concentration)
• Position value at $120k: $1,095 (captured most of the price movement)
• Impermanent loss already reflected in position value
• Net result: $1,095 + $25 = $1,120 (+12%)

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These examples assume specific fee tiers and volumes for illustration. The concentrated position that exits its range misses subsequent price gains but may earn higher fees while active. Real results vary significantly based on actual trading volume, competition, and rebalancing timing.

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When to Choose Each Approach

Choose Traditional Liquidity When:

You're new to DeFi, prefer passive earning, or have limited time for management. It's also optimal during high volatility, uncertain price direction, or when major events are pending. Traditional liquidity suits those seeking steady, predictable returns without management overhead.

Traditional liquidity particularly excels in:

• New token launches (extreme volatility)
• Bear markets (unpredictable movements)
• Long-term holding strategies (6+ months)
• Learning phase for new users

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Choose Concentrated Liquidity When:

You're experienced in DeFi and comfortable with complexity, actively managing positions daily, and seeking maximum returns. It works best in stable, range-bound markets with predictable patterns and clear support/resistance levels.

Concentrated liquidity is great for:

• Stablecoin pairs (minimal price movement)
• High-volume established pairs
• Range-bound markets
• Professional market makers
• Short-term yield optimization (days to weeks)

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Common Scenarios: Which Approach Wins?

Stablecoin pairs generally favor concentrated liquidity. With hUSDC/hUSDT rarely moving beyond 0.99-1.01, efficiency gains can be substantial, with minimal rebalancing needed. However, these obvious opportunities attract heavy competition.

New token launches suit traditional liquidity better due to extreme volatility and price discovery phases where concentrated positions would need constant adjustment and face severe IL.

Long-term passive earners should choose traditional liquidity for its hands-off approach and consistent returns without the need to monitor positions.

Active traders with edge can maximize concentrated liquidity's potential through active management, but must account for competition from automated strategies and professional market makers.

Bull market rallies depend on your execution ability - traditional provides steady returns with predictable IL, while concentrated can capture higher fees if you successfully adjust ranges with the trend (but many will be trying the same strategy).

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Tools and Platforms on Radix

The Radix ecosystem offers several platforms supporting various liquidity provision models. Both Ociswap and CaviarNine offer concentrated liquidity implementations (CaviarNine calls theirs "Shaped Liquidity").

Important Protocol Differences: Each DEX implementation has unique characteristics:

• Ociswap: Concentrated liquidity, multiple pool fee tiers (chosen at pool creation), single-sided liquidity options, protocol-owned liquidity
• CaviarNine: Shaped Liquidity (concentrated), order book functionality, LSULP liquid restaking, single-sided liquidity options, Hyperstaking, token aggregator for routing

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Conclusion

Traditional and concentrated liquidity each serve important roles in DeFi. Traditional liquidity provides the foundational layer of always-available liquidity with simple, passive management. Concentrated liquidity offers sophisticated traders the tools to improve capital efficiency, though real-world gains are often more modest than theoretical maximums due to competition, costs, and risks.

Neither approach is universally superior. The best choice depends on your experience level, available time, risk tolerance, market conditions, and competitive dynamics. Many successful liquidity providers use both models, allocating capital based on specific pair characteristics and market environments.

Start with traditional liquidity to understand the fundamentals. Once comfortable with concepts like impermanent loss and fee accumulation, experiment with concentrated positions using small amounts. Over time, you can develop intuition for when each approach makes sense and learn to recognize when competition or market conditions favor one strategy over another.

As the DeFi ecosystem matures, expect these dynamics to continue evolving. What works today may be less effective tomorrow as new technologies, strategies, and participants enter the market.